Current Expected Credit Losses (CECL) for Mortgage Banking

Transcription

1 Current Expected Credit Losses (CECL) for Mortgage Banking November 15, 2017 Presented by: Matthew Streadbeck, Partner, Ernst & Young LLP Carrie Kennedy, Partner, Moss Adams, LLP Jonathan Prejean, Managing Director, Deloitte Topics Executive summary Overview of expected credit loss model AFS debt securities Purchased financial assets with credit deterioration (PCD) Disclosures Effective dates, transition and PBE considerations Implementation considerations 2 1

2 Executive summary 3 Credit losses (ASU ) Executive summary All entities CECL objective: Recognize allowance reflecting all contractual cash flows not expected to be collected Reasonable and supportable forecasts Information about current conditions Current expected credit loss (CECL) model Financial assets measured at amortized cost: Trade receivables, reinsurance receivables, loans, held-to-maturity (HTM) debt securities, reverse repos Net investment in leases recognized by a lessor Off-balance-sheet credit exposures not accounted for as insurance AFS debt security impairment model Available-for-sale (AFS) debt securities Model for certain beneficial interests classified as HTM or AFS that are not of high credit quality No incurred threshold Allowance for credit losses Historical lifetime loss data (e.g., vintage) Risk of loss, even if that risk is remote Time value of money The new CECL model will generally accelerate the measurement and recognition of credit losses and increase earnings volatility Entities will be required to disclose significantly more information Today s concept of other-than-temporary impairment (OTTI) for AFS debt securities will also be modified Implementation has begun, led by banks Entities will be required to use more judgement and will likely need to gather and retain additional data and enhance modelling capabilities 4 2

3 Scope of new US GAAP impairment standard Executive summary All entities Financial assets measured at amortized cost: Financing receivables (loans) Held-to-maturity (HTM) debt securities Trade receivables Reinsurance receivables Current expected credit loss model Receivables that relate to repurchase and securities lending agreements Net investment in leases recognized by a lessor Off-balance-sheet credit exposures not accounted for as insurance AFS debt security impairment model Available-for-sale (AFS) debt securities Model for certain beneficial interests classified as HTM or AFS that are not of high credit quality These models also include an allowance gross-up approach for purchased financial assets with evidence of credit deterioration. 5 Mortgage banking impacts Executive summary No direct impact Interest rate lock commitments (IRLCs) Loans Held-for-Sale (HFS) TBA/Forward hedges Mortgage Servicing Rights (MSRs) Trading securities Greatest impact Loans Held-for-Investment (HFI) Held to Maturity (HTM) securities Available-for-Sale (AFS) securities Potential impact Representation and warranty reserves (Rep & Warranty) Servicing advance receivables 6 3

4 Overview of expected credit loss model 7 Core concepts Objective Recognize an allowance for credit losses that results in the financial statements reflecting the net amount expected to be collected from the financial asset Core concepts Base on an asset s amortized cost Reflect losses over an asset s contractual life Consider available relevant information Reflect the risk of loss Amortized cost basis includes premiums or discounts, foreign exchange and fair value hedge adjustments Contractual life will be adjusted for prepayments, but not extensions, unless a TDR is reasonably expected Entities will consider information about past events, current conditions and forecasts about the future that are reasonable and supportable The standard requires a pool-based approach when similar risk characteristics exist, and entities should consider the risk of loss even when that risk is remote 8 4

5 Based on an asset s amortized cost Based on an Based asset s on an asset s amortized cost amortized cost TRG issues: Prepayment adjusted discount rate Beneficial interests Reflect losses over an asset s contractual life Consider available relevant information Reflect the risk of loss Expected loss refers to the expected losses of the amortized cost basis of an asset If an entity measures the allowance for credit losses: Using a discounted cash flow approach The allowance should reflect the difference between the amortized cost basis and the expected cash flows discounted to a present value at the effective interest rate. Not using a discounted cash flow approach The allowance should reflect the expected credit losses of the amortized cost basis Amortized cost Amortized cost Unpaid principal balance Accrued interest Premiums/ discounts Net deferred fees/costs Foreign exchange FV hedge adjustments Option 1 Estimate the allowance for credit losses based on the entire amortized cost Option 2 Estimate the allowance for credit losses based on the individual components of amortized cost 10 5

6 Reflect losses over an asset s contractual life Life of a credit card (TRG) Forecasting TDRs (TRG) Extensions Based on an asset s amortized cost Reflect losses over an asset s contractual life Consider available relevant information Reflect the risk of loss Expected credit losses should reflect losses that are expected over the remaining contractual life of an asset The life of an asset generally would not include expected extensions, renewals or modifications (unless the entity reasonably expects to execute a TDR with the borrower) Expected credit losses should reflect expected prepayments, which mitigate potential loss 11 Consider available relevant information Reasonable and supportable forecast periods Reverting to historical data Beneficial interests (TRG) Based on an asset s amortized cost Reflect losses over an asset s contractual life Consider available relevant information Reflect the risk of loss Reasonable and supportable forecasts Historical loss information Current conditions Qualitative factors should be considered 12 6

7 Information to consider Credit profile of borrower Borrower s financial condition, credit rating, asset quality or business prospects Borrower s failure to make scheduled interest or principal payments Remaining payment terms of the financial asset Remaining time to maturity and the timing and extent of prepayments on the financial asset Value of underlying collateral when the collateraldependent practical expedient has not been used Environmental factors of a borrower An entity s other considerations Nature and volume of the entity s financial assets Volume and severity of past-due financial assets and the volume and severity of adversely classified or graded financial assets Lending policies and procedures, including changes in underwriting standards and collection, write-offs and recovery practices Quality of the entity s credit review system Experience, ability and depth of the entity s management and other relevant staff Areas in which the entity s credit is concentrated 13 Forecasting New standard provides little application guidance on How to develop a forecast What the forecast should cover For periods in which the entity is unable to reasonably and supportably forecast expected credit losses, the entity should revert to historical credit loss information that is reflective of the asset s contractual term Reversion may be immediate, on a straight-line basis or using another rational and systematic basis Potential economic variables Gross domestic product Inflation Unemployment Interest rate environment Credit spreads Business confidence metrics House price indices Factory orders Bankruptcies Stock market indices Savings rates 14 7

8 Reversion techniques Immediate reversion Straight-line reversion Other rational reversion Forecast Forecast Forecast Time Time Time 15 Reflect the risk of loss Zero credit losses transition (TRG) Charge-offs Freestanding insurance Based on an asset s amortized cost Reflect losses over an asset s contractual life Consider available relevant information Reflect the risk of loss Expected credit losses should include a measure of the expected risk of credit loss, even if that risk is remote Level of aggregation Requires a collective or pool-based approach when similar risk characteristics exist Allows individual approach when there are no shared risk characteristics An entity is not permitted to estimate a zero loss simply because the current value of the collateral exceeds the financial asset s amortized cost basis There are only limited circumstances under which an estimate of zero expected loss would be appropriate 16 8

9 AFS debt securities 17 What s changing? AFS debt securities FASB made targeted amendments to the existing impairment guidance Current guidance Recognize other-than-temporary impairment as a reduction of the security s cost basis Recognize reversals of impairment as an adjustment to future interest income New standard Recognized through an allowance for credit losses Recognize reversals of impairment immediately as a reduction of the allowance for credit losses Focuses on whether the impairment is other than temporary Focuses on whether the unrealized loss results, at least in part, from a credit loss The length of time a security has been in an unrealized loss position may not be used as a factor, by itself or in combination with others, to conclude whether there is a credit loss. Entities will need to develop new processes to identify securities that contain credit impairment. 18 9

10 Debt securities AFS debt securities Decision tree based on the Accounting Standard Update (ASU) , Measurement of Credit Losses on Financial Instruments. 1. Does Company A intend to sell the security? No 2. Is it more likely than not Company A will be required to sell the security before it recovers in value? No 3. Is a portion of the unrealized loss a result of a credit loss? Yes Yes Yes No Recognize impairment loss in earnings by writing down the security s amortized cost basis to FV. Recognize credit loss in earnings by recording an allowance for credit losses. Portion of loss related to other factors will continue to be recognized in other comprehensive income (OCI). 19 Transition considerations AFS debt securities Cumulative-effect adjustment to the opening retained earnings as of the beginning of the first reporting period in which the standard is effective. Similarly, debt securities on which other-than-temporary impairment had been recognized prior to the effective date will transition to the new standard prospectively (i.e., with no change in the amortized cost basis of these securities). The effective interest on the security will remain unchanged. Similar to today s practices: Amounts previously recognized in accumulated other comprehensive income as of the adoption date that relate to improvements in cash flows will continue to be accreted to interest income over the remaining life of the debt security on a level-yield basis. Recoveries of amounts previously written off relating to improvements in cash flows after the date of adoption will recorded into income in the period received. Follow PCD transition considerations for those debt securities classified as PCI prior to the adoption of the standard

11 Comparison between AFS and HTM AFS debt securities Topic AFS debt security impairment model* HTM current expected credit loss model Unit of measurement Individual AFS debt security Collective (pool) when similar risk characteristics exist; otherwise, individual Allowance recognition threshold When a decline in fair value below the amortized cost basis has resulted from a credit loss None Measurement of credit losses Excess of the amortized cost basis over the best estimate of the present value of cash flows expected to be collected, limited by the amount that fair value is less than amortized cost Expected credit loss that reflects the risk of loss even if that risk is remote Acceptable methods for measuring credit losses Discounted cash flow (DCF) Various methods are appropriate, including DCF, loss rate, probability of default (PD) and others that faithfully estimate collectability by applying the principles in ASC * When the entity has decided to sell the debt security or it s more likely than not the entity will be required to sell the security before recovery of the security s amortized cost basis, the security s amortized cost basis should be written down to fair value through earnings at the reporting date. 21 Purchased financial assets with credit deterioration (PCD) 22 11

12 From PCI to PCD Purchased financial assets with credit deterioration (PCD) Guidance in ASC that applies to purchased credit-impaired financial assets would be eliminated Entities would apply an allowance gross up approach for purchased financial assets with evidence of credit deterioration Definition of a PCD financial asset ASU PCD Acquired individual financial assets (or acquired groups of financial assets with shared risk characteristics) that, as of the date of acquisition, have experienced a more-thaninsignificant deterioration in credit quality since origination, as determined by an acquirer s assessment. Current GAAP PCI Loans with evidence of deterioration of credit quality since origination acquired by completion of a transfer for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable 23 Accounting Overview Purchased financial assets with credit deterioration (PCD) Initial accounting: allocate to each individual financial asset the non-credit-related discount or premium resulting from acquiring a pool of PCD assets Subsequent accounting for PCD assets will be the same as other originated loans Allowance for credit loss method Does not discount future expected cash flows Does discount future expected cash flows Base the allowance on the par amount of the PCD asset Assume Company A acquires a PCD asset with the following characteristics: Par amount of $100,000 Purchase price of $80,000 Credit loss embedded in the $20,000 purchase discount is $15,000 Use the discount rate that equates the purchase price of the PCD asset with the present value of estimated future cash flows Journal entry at purchase: Debt instrument (par amount) 100,000 Debt instrument (noncredit discount) 5,000 Allowance for credit losses 15,000 Cash 80,000 Non-credit discount of $5,000 would be accreted into interest income over the life of the instrument The allowance recorded at acquisition would not flow through the income statement 24 12

13 Transition considerations Purchased financial assets with credit deterioration (PCD) Prospective application for all assets that were PCI prior to adoption Gross-up adjustment to the amortized cost basis for the allowance for credit losses at the date of adoption No reassessment of PCD at the adoption date Loan pools accounted for under ASC may be maintained No reassessment of whether prior modifications of PCI loans in pools are TDRs at the adoption date PCI=>PCD pools will follow ASC 326 for allowance measurement Transition provisions were discussed at the June 2017 TRG Meeting 25 Disclosures 26 13

14 Credit losses (ASU ) Disclosures Forecasts Discuss the factors that influenced management s reasonable and supportable forecasts. For forecast periods beyond which management deems are reasonable and supportable, discuss the reversion method applied in the allowance calculation. Purchased financial assets with credit deterioration Reconcile the difference between the purchase price of the financial assets and the par value of the assets for purchased financial assets with credit deterioration Rollforward of the allowance By portfolio segment and major security type, provide the quantitative disclosures of the activity in the allowance for credit losses for financial assets (also applies to AFS and HTM debt securities). Vintage analysis for certain in scope assets Disclose the amortized cost amount within each credit quality indicator by year of origination for the most recent five years (PBE s only) Loan commitments Describe the accounting policies and methodology used to estimate the liability and discuss relevant risk elements Collateral-dependent financial assets Describe the type of collateral by class of financing receivable and major security type and the extent to which collateral secures financial assets. Also qualitatively explain, by class of financing receivable and major security type, significant changes in the extent to which the collateral secures the entity s financial assets. Qualitative disclosures Discuss how the allowance was developed including the factors that influenced management s estimate such as past events and current conditions as well as the changes in those factors 27 Effective dates, transition and PBE considerations 28 14

15 Effective date and transition Type of entity Effective date Early adoption? Public business entities (PBEs) that are SEC filers Annual periods beginning after December 15, 2019, and interim periods therein Other PBEs Annual periods beginning after December 15, 2020, and interim periods therein All other entities Annual periods beginning after December 15, 2020, and interim periods within annual periods beginning after December 15, 2021 Yes, annual periods beginning after December 15, 2018, and interim periods therein An entity will apply the new guidance using a modified retrospective approach Recognize a cumulative-effect adjustment as of the beginning of the first reporting period in which the guidance is effective Transition relief provided for: Purchased financial assets currently accounted for under ASC Debt securities for which an other-than-temporary impairment has already been recognized 29 Public Business Entities (PBE) considerations Required to file or furnish financial statements with the SEC Required by the Securities Exchange Act of 1934 to file or furnish financial statements with a regulatory agency other than the SEC. Consider 1) Do insured depository institutions without a bank holding company fall into this category? ASU Are you a PBE? Required to file or furnish financial statements with a foreign or domestic regulatory agency in preparation for the sale of or for purposes of issuing securities Consider 1) Does an implied contractual restriction exist when a bank is wholly owned by a parent? Does the bank meet the first criteria? 2) If an institution files Call Reports, does it meet the second criteria? Meet both conditions: 1) Has securities that are not subject to contractual restrictions on transfer, and 2) Required by law, contract, or regulation to prepare GAAP financial statements and make them publicly available on a periodic basis. Issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market Consider 1) What does it mean for a security to be traded, listed, or quoted? 2) What constitutes an over-the counter-market 3) Do brokered CDs fit in this category? 30 15

16 Implementation considerations 31 Interpretation of the credit loss standard is being influenced by a variety of constituents The model will have implications on: Communications with investors and analysts Capital management Data, technology and processes Product pricing Internal controls Internal audit functions External audits Regulatory interactions Financial institutions SEC Accounting firms FASB and the Impairment Transition Resource Group Industry groups (e.g., ABA) Bank regulators (FRB, OCC, FDIC, NCUA) AICPA IFRS 9 constituents Investors and analysts The measurement of credit losses is exceptionally important to the [banking regulatory agencies] as it is one of the most significant accounting estimates for the nearly 14,000 financial institutions we supervise. Interagency comment letter in response to FASB s December 2012 exposure draft on credit losses 32 16

17 CECL will have business implications What is the impact to the customer and customer experience? Cost of compliance and impact to profitability and pricing Change in lending strategy Increased data requirements Implementation of new controls Will lending strategy change? Contractual maturity Prepayment terms Product mix Collections and refinance Distressed asset management Origination and screening Credit exposure transaction lifecycle Underwriting and approvals Servicing Closing and funding How will pricing models and performance measures incorporate impact to reserve? Are controls over CECL forecasting and disclosure data sufficient to support financial reporting? Are servicing systems able to provide necessary data for modeling and disclosures? Can today s FAS 114 methodology and process be leveraged under CECL? Surveillance and monitoring Is portfolio management process leveraging and benefiting from CECL-related investments? 33 17